Philippines

THE SERVICE SECTOR

Finance

The Philippine financial system in the early 1990s was
composed of banking institutions and nonbank financial
intermediaries, including commercial banks, specialized
government banks, thrift and rural banks, offshore banking units,
building and loan associations, investment and brokerage houses,
and finance companies. The Central Bank and the Securities and
Exchange Commission maintained regulatory and supervisory
control. The Philippines had a relatively sophisticated banking
system; however, the level of financial intermediation was low
relative to the size of the economy. In the late 1970s and early
1980s, a number of policy reforms were initiated to strengthen
the system, but financial crises in 1981 and 1983 short-circuited
their full effect. The financial community has undertaken
recovery efforts since 1986.

Until the economic crisis of the mid-1980s, the largest
commercial bank in the Philippines was the government-owned
Philippine National Bank. Created in 1916 to provide agricultural
credit for export crops, the Philippine National Bank accounted
for 25 percent to 30 percent of commercial bank assets in the
1970s and early 1980s. As the result of the accumulation of
nonperforming assets, by 1987 the asset share of the Philippine
National Bank had fallen by half. In 1988 there were twenty
privately-owned domestic banks and four branches of foreign banks
engaged in commercial banking. Since the passage of the General
Banking Act of 1948, foreign investment in banking has been
limited to 40 percent of domestic bank equity. Total assets of
the commercial banking system in 1988 were about P330 billion.

The Philippine government controlled three specialized banks
in 1991: the Development Bank of the Philippines, the Land Bank
of the Philippines, and the Philippine Amanah Bank. The
Development Bank of the Philippines, established in 1946 and
initially designed to facilitate postwar rehabilitation, provided
long-term finance. It supplied 47 percent of long-term loans and
15 percent of the medium-term loans. More than 70 percent of its
loans were allocated to industry. The Land Bank of the
Philippines, established in the early 1970s, financed the
government land reform program. The Philippine Amanah Bank,
organized in the mid-1970s, served Muslims in the southern
Philippines. Offshore banking units have been allowed to do
business in the Philippines since 1977. Also since 1977, certain
domestic banks have been allowed to take foreign-currency
deposits and engage in foreign-currency lending.

From its inception in 1948 until 1980, the Central Bank
extensively regulated the commercial banking system and engaged
in considerable rediscounting activity. Interest rates were set
administratively, usually below the market clearing rate.
Commercial bank lending tended to be short-term and granted to
known, established borrowers. The system had periods of
instability with several bank runs and a few failures. In 1980,
at the instigation of the World Bank and the IMF, several
measures were passed to increase competition in the financial
sector, achieve greater efficiency, and increase borrowers'
access to long-term funds. Large banks with a net worth of at
least P500 million could engage in expanded commercial banking,
or "unibanking," combining commercial and investment banking
activities. In 1988 there were eight unibanks, including the
Philippine National Bank. Further liberalization had occurred in
1983 when interest rates shifted from being administered to being
market-determined.

Interest-rate ceilings had led to an excess demand for loans
and credit rationing. The Malacaņang Palace interfered in loan
decisions regarding state-owned banks, weakening the quality of
bank portfolios. It was argued that a market-determined interest
rate would make such behavior less rewarding and more difficult.
However, before the interest rate reform could be initiated and
before the expanded commercial bank reform had an impact on the
banking industry, a series of crises hit the Philippines,
throwing the country's financial system into disarray.

The economic and political crisis that occurred in the
aftermath of the assassination of Marcos's political rival,
Benigno Aquino, resulted in a virtual collapse of much of the
banking industry, particularly the smaller institutions. The
larger banks suffered substantial losses from the drastic
devaluations of the peso between 1983 and 1985. Commercial bank
loans increased slightly in 1984, but then fell almost 30 percent
in the following two years--from P116 billion to P83
billion--before turning upward again. Inflation during that
three-year period was almost 80 percent. The two largest
financial intermediaries, the Philippine National Bank and
Development Bank of the Philippines, became insolvent, and a
number of financial institutions failed, including the three
largest investment houses, three commercial banks, the majority
of the more than 1,000 rural banks, and the largest savings bank.

The Aquino government undertook a rehabilitation program for
the Philippine National Bank and Development Bank of the
Philippines. In 1986 nonperforming assets of the two institutions
were transferred to the government, reducing the value of the
assets of the Philippine National Bank by 67 percent and that of
the Development Bank of the Philippines by 87 percent. The
relative importance of these two banks in the financial sector
diminished dramatically. The domestically owned commercial
banking sector, however, became more concentrated. From the
mid-1950s to the early 1980s, the five largest private domestic
commercial banks accounted for about 35 percent of total assets
of the private domestic commercial banks. By 1988 that ratio had
risen to around 55 percent. The combined assets of the five
private domestic commercial banks, the Philippine National Bank,
and the two largest foreign branch banks accounted for two-thirds
of total commercial bank assets, up from 56 percent in 1980.

In 1990 the six largest commercial banks earned an estimated
P7.9 billion in after-tax profits, an increase of 42 percent over
1989, which in turn was a 32 percent increase over 1988. A 1991
World Bank memorandum noted that the extent of bank profits
indicated a "lack of competition" and a "market structure for
financial services characterized by oligopoly." Philippine banks
had the widest interest rate spread (loan rate minus deposit
rate) in Southeast Asia.